Creditor Control and Product Market Competition

Abstract

We explore how rival firms respond when firms in their industry violate debt covenants. We find that rival firms increase advertising expense, and that this increase is proportional to the size of industry violators’ pre-existing market share. We also find that rival firm product-market share increases in the industry market share of violators, and that this relation is more pronounced when products are more substitutable. Rival firm operating performance also increases in proportion to the industry market share of violators. Overall, these findings suggest that the increased creditor control associated with covenant violations has a significant influence on rival firms and product-market competition.